The Real Cost of Low Interest Rates
Monetary policy and quantitative easing are becoming an increasingly destabilizing force in financial markets. While the Federal Reserve’s introduction of QE post Lehman prevented a deeper recession than would have otherwise materialized, its effects 7 years on are still being felt by individuals and businesses alike. It’s becoming increasingly clear that the ongoing zero percent interest rate policies being pursued by central banks are causing drastic distortions and malinvestment throughout the global economy, with savers in particular being heavily disadvantaged.
The concentration of cheap credit in the financial sector has empowered speculators at the expense of savers, sparking bubbles in select asset classes like equities, real estate, and bonds. Unprecedented increases in the money supply are being used as weapons in an increasingly hostile global currency war, debasing fiat currencies and reducing purchasing power of ordinary workers and savers. These are often abstract concepts, the effect of which are not felt by individuals on a daily basis. What is less abstract however, and perhaps the most insidious consequence of current monetary policy, is the enormous confiscation of wealth from ordinary savers.
Interest Income is Non Existent
For anyone actively involved in managing their own savings and investments, the effects of these policies are crystal clear. Zero interest rate policies are completely obliterating ordinary people’s ability to save effectively, with a disproportionate share of the pain being placed on the shoulders of retirees.
Retirees are heavily dependent on interest income to fund their lifestyle after they have stopped working, and as such are amongst the most disadvantaged by the low interest rate policies in place throughout the world.
Assuming a worker has saved $500,000 over the course of their lifetime and is now looking for a fixed income investment to provide an annual stream of income, the typical certificate of deposit (CD) rate on offer is 1.5% – this translates in a pre tax income of $7,500 per annum. In the year 2000, the same certificate of deposit would yield close to 6%, and would generate an annual income of $30,000 per annum. Current retirees are receiving 75% less interest income as a result of the artificially low interest rates which are currently in place.
The lack of yield worldwide is forcing investors into riskier forms of investments, distorting the true cost of capital. “Junk” rated securities are now trading at levels historically reserved for only the strongest corporations. On the other end of the scale, the safest rated government bonds trade at negative interest rates, investors are literally paying the government to hold their money! The risk pricing model is broken, and will continue to be broken as long as the central banks continue placing the welfare of wall street and big corporations in higher regard than the ordinary saver.
The looming pension crisis
Going forward, the low interest rate environment is going to be an increasingly sensitive political issue, Demographics in most of the world’s developed economies are likely to see a dramatic increase in the amount of retirees entering the system over the next decade as the baby boomer generation start hanging up their work boots in earnest. The inability of these retirees to survive off of their pension could potentially trigger another round of financial crises.
Retirees are not the only people suffering. Long term insurers are also facing substantial difficulties with their traditional business models. The lack of yield generating investments are forcing them into riskier asset classes, as a consequence insurance premiums are set to rise globally as insurers are unable to generate enough returns to sustain the current model.
In some countries, the low interest rate environment hurts retirees even further as they often have no choice in what their savings are plowed into – they are often required by law to purchase government bonds with their nest egg which provide the basis of a lifetime annuity. With the paltry rates on offer from such government bonds, income for retirees has been cratering, sometimes as much as 80% since the proliferation of QE and ZIRP.
Savers need to cast their nets wider
Savers in the United States are still fortunate to have a multitude of options available to them including individual retirement accounts (IRAs) which provide a good deal of flexibility for savers looking to maximize the income generating capability of their savings. IRAs allow investors to invest in a vast array of asset classes, and provide the flexibility to construct retirement portfolios which can help mitigate some of the more disastrous effects ZIRP. Higher yielding overseas bonds, equities, even precious metals, can all be held within an IRA structure, offering significant diversification benefits for ordinary investors. While IRAs are relatively simple to set up, investors should always conduct their own independent due diligence and consult with a tax and investment professional on the best way to structure their plan.
The current financial environment is one of the worst in history for savers, and given the incredible amounts of public and private debt circulating within the global economy, artificially low interest rates are likely to remain in place for the foreseeable future. In an increasingly hostile investment environment, savers need to evaluate all of their options to ensure they are maximizing their potential income in retirement, IRAs are definitely one way of doing so.